Monday, November 25, 2013

The Fed’s Catch 22 just got catchier. While most attention in the recently
released FOMC minutes fell on the return of the taper as a possibility even
as soon as December (making the November payrolls report the most important
ever, ever, until the next one at least), a less
discussed issue was the Fed’s comment that it would consider lowering the
Interest on Excess Reserves to zero as a means to offset the implied tightening
that would result from the reduction in the monthly flow once QE entered its
terminal phase (for however briefly before the plunge in the S&P led to the
Untaper). After all, the Fed’s policy book goes, if
IOER is raised to tighten conditions, easing it to zero, or negative, should
offset “tightening financial conditions”, right? Wrong. As the FT reports
leading US banks have warned the Fed that should it lower IOER, they
would be forced to start charging depositors.

Image: Chase Bank (Wikimedia Commons).

In other words, just like Europe is already toying with the idea of NIRP
(and has
been for over a year, if still mostly in the rheotrical and market rumor
phase), so the Fed’s IOER cut would also result in a negative rate on deposits
which the FT tongue-in-cheekly
summarizes “depositors already have to cope with near-zero interest rates,
but paying just to leave money in the bank would be highly unusual and unwelcome
for companies and households.”

If cutting IOER was as much of an easing move as the Fed believes, banks
should be delighted – after all, according to the Fed’s guidelines it would mean
that the return on their investments (recall that all US banks slowly but surely
became glorified, TBTF prop trading hedge funds since Glass Steagall was
repealed, and why the Volcker Rule implementation is virtually guaranteed to
never happen) would increase. And yet, they are not:

Executives at two of the top five US banks said a cut in the 0.25 per cent
rate of interest on the $2.4tn in reserves they hold at the Fed would lead them
to pass on the cost to depositors.

Banks say they may have to charge because taking in deposits is not free:
they have to pay premiums of a few basis points to a US government insurance
programme.
“Right now you can at least break even from a revenue perspective,” said one
executive, adding that a rate cut by the Fed “would turn it into negative
revenue – banks would be disincentivised to take deposits and potentially charge
for them”.
Other bankers said that a move to negative rates would not only trim margins
but could backfire for banks and the system as a whole, as it would incentivise
treasury managers to find higher-yielding, riskier assets.
“It’s not as if we are suddenly going to start lending to [small and
medium-sized enterprises],” said one. “There really isn’t the level of demand,
so the danger is that banks are pushed into riskier assets to find
yield.”

All of the above is BS: lending has never been a concern for the Fed because
if it was, then one could scrap QE right now as an absolute faiure. Recall that
as we showed recently, the total amount of loans and leases in
commercial US banks has been unchanged since Lehman, with the only rise
in deposits coming thanks to the fungible liquidity injected by the Fed.

Furthermore, contrary to what the hypocrite banker said that “the danger
is that banks are pushed into riskier assets to find yield”, banks
are already in the riskiest assets: just look at what JPM was doing
with its hundreds of billions in excess deposits, which originated as Fed
reserves on its books – we explained the process of how the Fed’s reserves are
used to push the market higher most recently in “What
Shadow Banking Can Tell Us About The Fed’s “Exit-Path” Dead End.”

What the real danger is, is that once the Fed lowers IOER and there is a
massive outflow of deposits, that banks which have used the excess deposits as
initial margin and collateral on marginable securities to chase risk to record
highs (as JPM’s CIO explicitly and undisputedly did) that there would be an
avalanche of selling once the negative rate deposit outflow tsunami hit.

Needless to say, the only offset would be if the proceeds from the deposits
outflows were used to invest in stocks instead of staying inert in some mattress
or, worse (if only from the Fed’s point of view) purchase inert assets like gold
or Bitcoin.

Which brings us back to the first sentence and the Fed’s now massive Catch
22: on one hand, shoud the Fed taper, rates will surge and stocks will once
again plunge, as they did, in early summer, just to teach the evil,
non-appeasing Fed a lesson.

On the other hand, should the Fed cut IOER as a standalone move or
concurrently to offset the tapering pain, banks will crush depositors
by cutting rates, depositors will pull their money from banks en masse, and
banks will have no choice but to close on a record levered $2.2
trillion in margined risk position.